House of Commons - Treasury

Select Committee on Treasury Fourth Report

2 THE ECONOMICS OF THE STERN REVIEW

6. With a length of 579 pages, the Stern Review is a comprehensive and ambitious document. Sir Nicholas Stern explained to us that his Review, whilst not necessarily covering new ground in terms of understanding climate change science or the economic tools available to reduce carbon emissions, differed from previous economic analyses in three primary ways: It considered the economics of climate change risk; it considered the issue of achieving international consensus on climate change action; and it considered the equity implications of climate change.[14]

OVERALL ANALYSIS OF THE STERN REVIEW

7. Professor Ekins noted that most of the arguments rehearsed in the Stern Review have been available for some time, but the "novelty" of the Stern Review was in Sir Nicholas' choice of emphasis. First, Professor Ekins noted, Sir Nicholas addressed the science of climate change, which was unusual for an economist. He then focused on the equity and social justice issues, which in Professor Ekins' view was the correct way to start, because these "are very important public social as well as economic issues".[15] Many organisations welcomed the Stern Review: Natural England, for example, argued that the central finding of the Stern Review, that inaction will be more costly to the global economy than immediate action, had sent a strong signal to the international community and further demonstrated the UK's global leadership on this issue.[16]

8. The Government has accepted the Stern Review's analysis, the thrust of its conclusions and the policy direction that it suggests.[17] The Minister commented that:

KEY FINDINGS OF THE STERN REVIEW

9. The Stern Review argued that there is now overwhelming scientific evidence that climate change is a serious global threat and that this threat demands an urgent global response. The Review concluded that the benefits of strong and early action to reduce carbon emissions would outweigh the economic costs of not acting and warned that the consequences will be wide-ranging and severe if the world fails to act:

Climate change will affect the basic elements of life for people around the world—access to water, food production, health, and the environment. Hundreds of millions of people could suffer hunger, water shortages and coastal flooding as the world warms.[

10. The Stern Review estimated that the overall costs of climate change if no preventative action were taken would be equivalent to losing at least 5% of global gross domestic product (GDP) each year, now and forever. When considering a wider range of risks and impacts, these costs could rise to 20% of GDP or more. According to the Review, the costs of preventative action, such as reducing greenhouse gas emissions to avoid the worst impacts of climate change, could be limited to around 1% of global GDP each year. The Review stressed that decisions made in the next couple of decades would have a "profound effect on the climate in the second half of this century and in the next".[20] If no action were taken to reduce emissions, the Review estimated that the concentration of greenhouse gases in the atmosphere could double its pre-industrial level by 2035, which would lead to a global average temperature rise of over 2°C. In the longer term, "there would be more than a 50% chance that the temperature would increase by more than 5°C".[21] This would result in major changes to the world's physical geography, which would lead to changes in where, and how, people could live their lives. Despite these grave warnings, the Review was optimistic that the costs of stabilising the climate were manageable:

11. Sir Nicholas explained that, if mankind were to take no action to reduce carbon emissions for 30 years, it would be very difficult to achieve stabilisation of 550ppm. To achieve such stabilisation, he said, total emissions would have to peak 20 to 25 years from now and decisions and action had to be taken in the next few years.[23]

12. We welcome the Stern Review as an impressive document that contributes much to public discussion of climate change. Sir Nicholas Stern deserves credit for bringing into stark relief the problem of risk and uncertainty concerning potentially ruinous environmental catastrophes. We also support Sir Nicholas' attempts to frame the climate change debate in terms of economic choices, which should serve to assist policymakers in taking the difficult decisions necessary to combat climate change.

The international nature of the climate change problem

13. Climate change is, both in its causes and consequences, an international problem: The direct effects of global warming such as rising sea levels and more unpredictable weather affect countries without regard to the source of emissions. The Stern Review argued that "because climate change is a global problem, the response to it must be international … based on a shared vision of long-term goals and agreement on frameworks that will accelerate action over the next decade".[24]

14. The then Financial Secretary to the Treasury, John Healey MP,[25] stressed that the UK's ability to exert influence on the international stage was dependent on the UK demonstrating that it was possible to enjoy economic growth whilst simultaneously dealing with the emissions challenge.[26] Friends of the Earth commented that the adoption by the UK Government of a clear climate change strategy would have a galvanising effect amongst the international community.[27] The Centre for Sustainable Energy noted the "desperate need" for the Government to establish a clear and consistent 'framing' of the climate change issue in all its communications, because "it is only ever through leadership and example that international treaties are established that lead to effective global solutions".[28] The Minister highlighted the Government's efforts to encourage the European Union to adopt ambitious emissions reductions targets, and its ongoing work on climate change at the G8, International Monetary Fund and World Bank.[29]

15. The Stern Review described how countries will be affected in different ways:

The Review argued that, in both developed and developing economies, it would be possible to make the reductions in emissions on the scale necessary for stabilisation in the required range without endangering economic growth.[31] It noted that the developing world had an important role to play; "even if the rich world takes on responsibility for absolute cuts in emissions of 60-80% by 2050, developing countries must take significant action too. But developing countries should not be required to bear the full costs of this action alone."[32]

16. Economic growth in non-OECD [Organisation for Economic Co-operation and Development] countries, most notably China and India, is expected to lead to significant increases in global energy demand, with the non-OECD share of total energy demand projected to exceed half of the global total by 2015.[33] Such increases in demand for natural resources create environmental pressures, not least those relating to climate change. Professor Amartya Sen from Harvard University argued that international agreements on the environment had to address the problem of "historical fairness"—namely, that many developed nations attained their level of development without unduly considering the impact of their economic growth on the environment, so that it would be unfair of them subsequently to seek to restrict the growth of developing nations on the basis of environmental concerns.[34]

17. The Minister believed that the developed countries, which were "largely responsible for the emissions that are currently creating the climate change problems", had to accept a greater responsibility and a greater share of the cost of resolving the climate change problem.[35] Lord Lawson though was sceptical of the prospects for carbon emission abatement in the developing world. He did not see any prospect of China, for example, cutting back on its carbon emissions "unless somebody else pays for carbon capture and storage", which he said no country was likely to agree to.[36] However, the Minister stated that the Government was actively working with China on developing and deploying carbon capture and storage (CCS).[37] The 2007 Comprehensive Spending Review announced details of a competition to design and build a full-scale demonstration of CCS technology, which, the Government hopes, will contribute to the UK's ambition of assisting the transition of China and India to low-carbon economies.[38]

Criticisms of the Stern Review

THE INDEPENDENCE OF THE STERN REVIEW

18. The Stern Review was commissioned by the then Chancellor of the Exchequer, and reported to the then Prime Minister and Chancellor. The author, Sir Nicholas Stern, was at the time the serving Head of the Government Economic Service and a former Second Permanent Secretary in HM Treasury. There was some criticism that the Stern Review was not independent and was subject to political pressures. Professor William D Nordhaus of Yale University had written that the Stern Review should be viewed as a political document, rather than an academic study. Like most Government reports, he argued, it was published without an appraisal of methods and assumptions by independent outside experts.[39]

19. Lord Lawson argued that the Stern Review was "basically a work of advocacy", and that a "more objective, analytical approach would have been helpful". He suggested that the Review was biased, exaggerating the costs of warming and downplaying both the benefits of warming and the costs of mitigation:

In a lecture to the Centre for Policy Studies, Lord Lawson claimed that "as a good civil servant [Sir Nicholas] was simply doing his master's bidding".[41] In evidence to us, he explained that statement:

20. The Minister was adamant that the Stern Review was a "serious piece of work, carried out independently, with all the resources that [Sir Nicholas] needed from inside the Treasury and from outside as well in order for him to do that". He added that the Report's authority, credibility and integrity depended on the fact that Sir Nicholas conducted his Review independently and that, apart from Lord Lawson's criticism, he did not see any serious evidence or argument to the contrary.[43]

21. The Stern Review is a serious contribution to the climate change literature. Although Lord Lawson was concerned that Sir Nicholas was insufficiently independent of Government, we believe that the Review has to be judged by the quality of its evidence and the arguments it puts forward, rather than the issue of its authorship.

DISCOUNT RATES

22. Much of the discussion on the economics of the Stern Review has centred on the use of a particular "discount rate". In this context, the discount rate allows one to measure the value of future costs and benefits in today's terms. A high discount rate, for example, indicates a preference for consumption now rather than in the future. Choosing an appropriate discount rate, whilst a highly technical subject, is crucial to assessing the extent of sacrifices the world should be taking now to prevent or slow down climate change damage affecting future generations. The issue of discounting across long time horizons raises awkward questions of intergenerational equity, such as 'Should society be attempting to maximise welfare across all generations, or, alternatively, should it be seeking to equalise or smooth welfare across all generations?' Choosing a lower discount rate has the effect of promoting a reduction in current consumption, so that the world inherited by future generations is less damaged.

23. The Stern Review employed discounting assumptions that have caused some controversy amongst academic economists. Professor Ekins perhaps understated the debate when he said that "there has been a fair bit of controversy about how he arrived at his overall damage costs, in particular with the use of a discount rate that some perceived to be too small".[44] Lord Lawson referred to the critique made by Professor Sir Partha Dasgupta of Cambridge University:

Lord Lawson argued that the sacrifices expected of the current generation should be set against the fact that future generations are likely to be much richer and enjoy a better quality of life:

24. Sir Nicholas defended his discounting techniques when we questioned him. He explained how there were two reasons for discounting. The first reason was discounting for growth, the idea that "in future, people may be better off than we are currently. An extra unit of stuff in future therefore has lower ethical value."[47] Rejecting Lord Lawson's allegation, Sir Nicholas stated that his Review performed such discounting for growth in exactly the same way as the Treasury would normally do.[48]

25. The second reason for discounting, the pure time discount rate, is the discounting of future events for no other reason than that they are in the future, or, as Sir Nicholas described it, "the issue of how far we should discriminate between people by date of birth".[49] The Association of British Insurers pointed out that the pure time discount rate chosen by Sir Nicholas, 0.1%,[50] contrasted markedly with the rate of 1.5% used in the Treasury Green Book, the rate which is normally used by economists when discounting future cashflows in public policy evaluations.[51] The Stern Review argued that standard treatments of discounting were valuable for analysing marginal projects, but inappropriate for the non-marginal impacts important for many aspects of climate change.[52] In a working note for the Stern Review, Dr Cameron Hepburn of the University of Oxford argued that the relevant discount rate for climate change decisions should reflect the risk of "societal collapse" (for example, an entire region or country succumbing to rising sea levels) and, on this basis, should indeed be smaller than the current Treasury rate of 1.5% and possibly 0% to a first approximation.[53]

26. Sir Nicholas told us that the idea of discriminating on the grounds of date of birth was an ethical position that was "extremely hard to defend".[54] In his opinion there was little justification for such discounting when conducting cost benefit analysis at the planetary level (as with climate change), and argued that this approach was not unusual:

We note that some economists would disagree with Sir Nicholas' view that choosing a higher pure time discount rate was indefensible. Professor Nordhaus of Yale University, writing in the Journal of Economic Literature, listed four possible justifications for a different rate.[56]

27. Professor Ekins thought that, despite the controversy over the discounting assumptions used, Sir Nicholas' broad conclusion that the damages from unabated climate change would greatly exceed the costs of doing something about it and reducing the level of emissions, was "absolutely right."[57] Simon Roberts from the Centre for Sustainable Energy argued that the discount rate chosen was irrelevant to the central finding of the Stern Review that the costs of inaction far outweighed the costs of action:

28. Sir Nicholas was clearly aware of the significance of the ethical assumptions he made in his Review:

29. At the time of publication, the Stern Review offered only one discount rate possibility. Following some criticism from academics, Sir Nicholas later published a Postscript containing tables that showed the sensitivity of the Stern Review's findings to different choices of discount rate. However, no arguments were put forward explaining why other discount rates might be preferred by other economists, which, had they been provided, would have been helpful in facilitating debate about the relative merits of different discount rates.[60]

30. The Minister supported the assumptions underpinning the Stern Review.[61] He told us that the current generation had a particular responsibility in dealing with climate change and it was right that "we should not regard the value of the world [in future] any less than we do at the moment".[62]

31. The choice of discount rate used in the Stern Review is critical to its strong policy conclusions, because that choice is an important factor in the calculation of the costs (as valued today) arising from future climate change. We regret that there was not greater discussion of discount rates in the original Stern Review, including explanation and potential justification of alternative rates. We welcome the eventual publication of discount rate sensitivity tables in the Stern Review's Postscript, but note that the attention that these alternative rates received was substantially lower than might have been the case if acknowledgement of, and arguments for, other discount rates had been provided in the original Review.

Relying on adaptation

32. The most prominent strand of our inquiry was the role of the Treasury in limiting UK carbon emissions. Yet, however successfully this aim is pursued in the future, the UK and the wider world have to begin to adapt to climate change now. Regardless of future action, it is already certain that threats such as rising sea levels and more unpredictable weather patterns will make increasing demands on the Treasury's purse strings. Some adaptation will be inevitable, but we considered it important to examine where the balance lay between encouraging expenditure on adaptation methods rather than cutting emissions.

33. Lord Lawson told us that, although he had not calculated the monetary sum needed to adapt to climate change, it was "quite clear that it would be substantially less than the cost of going down the route of cutting back [on emissions] drastically".[63] He argued that an effective response to climate change would involve close monitoring of the consequences of warming, adaptation to those consequences where they were harmful and pocketing of benefits when the consequences were beneficial.[64] He took the view that although the impact of climate change could be severe, all kinds of other eventualities were possible, including the chance that the world might enter a new ice age over the next 100 years. He also argued that there were much more urgent problems to face such as terrorism, nuclear proliferation, and natural disasters, and that the UK could not guard against every possible contingency because it would be too expensive. He commented that, in the near future at least, the UK should be focused on the dangers arising from nuclear proliferation and international terrorism, saying "we should be careful about future threats and be careful not to spend resources unnecessarily".[65] For these reasons, he advocated limiting expenditure on cutting back emissions, instead focusing on monitoring and adaptation to the threat of climate change.

34. A response to the threat of climate change based on adaptation would have the advantage of enabling each nation to deal with the consequences piecemeal as and when they arose, in contrast to the emissions reduction approach, which Lord Lawson described as requiring an "extremely ambitious and implausible international agreement before you can do anything worthwhile".[66] In Lord Lawson's strategy, poorer countries unable to adapt to changes such as rising sea levels could receive financial assistance from richer countries, which, in his view, was a "far more practical approach [than mitigation of emissions] as well as being far more cost-effective."[67] He thought that the financial aid required would be manageable because of the economic growth in the developing countries that the Stern Review predicts:

35. Kate Hampton from Climate Change Capital believed that intelligent debate on adaptation had been slowed down because, historically, "adaptation has tended to be used as a card played by countries like the US and Saudi Arabia as a way to divert attention away from mitigation".[69] Sir Nicholas argued that the balance between adaptation and mitigation should not be viewed as a horse race and that both adaptation and mitigation would be important. However, he disputed Lord Lawson's argument that it made sense to see what happened before acting, because of the significant risk that by then it would be too late:

The Stern Review paid attention to the risk of catastrophic climate change, a scenario for which monitoring would simply be inadequate and too late. Professor Ekins agreed that catastrophic climate change risk was a growing theme in the scientific literature:

36. Lord Lawson's argument that adaptation was cheaper, easier and more flexible than attempting to mitigate emissions has its attractions. However, as Sir Nicholas Stern pointed out in his Review and in evidence to us, relying on monitoring and adaptation alone could prove to be too little, too late. The fact that adaptation will be required in the short to medium term, regardless of mitigation efforts, does not absolve the UK from its responsibility to reduce its carbon emissions. We support Sir Nicholas' recommendation that the Government pursue a twin-track approach: working to reduce emissions to a sustainable level, while at the same time committing sufficient resources to the monitoring of climate trends and adaptation, both in the UK and abroad.

14 Q 129 Back

15 Q 1 Back

16 Ev 132 Back

17 Q 251 Back

18 Q 325 Back

19 Stern Review, p vi-vii Back

20 Ibid., p vi Back

21 Ibid., p vi Back

22 Stern Review, p vii Back

23 Q 194 Back

24 Stern Review, p vi Back

25 hereafter referred to as "the Minister" Back